What Happens to the Premium When You Exercise a Call Option?

When you exercise a call option, the premium you paid for the option is not refunded or adjusted. The premium is essentially the cost of purchasing the option and compensates the seller for taking on the risk of potential price movements in the underlying asset. Exercising a call option means you are choosing to buy the underlying asset at the strike price specified in the option contract.

Here’s a detailed breakdown of what happens:

1. Premium Payment: When you initially buy a call option, you pay a premium to the option seller. This premium is a non-refundable fee for the right, but not the obligation, to purchase the underlying asset at the strike price before the option expires.

2. Exercising the Option: When you exercise the call option, you are opting to buy the underlying asset at the strike price. The premium you paid does not factor into this transaction directly. Instead, you pay the strike price for the asset.

3. Total Cost Calculation: The total cost of acquiring the underlying asset through the exercised option includes:

   • Strike Price: The agreed-upon price at which you buy the underlying asset.
   • Premium Paid: The cost of the option itself, which has already been paid.

4. Profit or Loss Calculation: To determine your profit or loss from exercising the option:

   • Calculate the Total Cost: Add the premium paid to the strike price.
   • Compare to Market Price: Subtract the total cost from the current market price of the asset. If the market price is higher than the total cost, you make a profit. If it’s lower, you incur a loss.

5. Example Scenario:

   • Premium Paid: $5 per share.
   • Strike Price: $50 per share.
   • Current Market Price: $60 per share.
   • Total Cost of Acquisition: $50 (strike price) + $5 (premium) = $55 per share.
   • Profit per Share: $60 (market price) - $55 (total cost) = $5 per share.

6. Impact on Option Seller: When you exercise the option, the seller of the call option is obligated to sell the underlying asset at the strike price. They do not receive any further compensation beyond the premium received initially.

7. Tax Considerations: In some jurisdictions, the premium paid might affect your tax situation. For example, the premium might be used to adjust the cost basis of the asset for tax purposes.

8. Alternative Strategies: Instead of exercising the call option, you might choose to sell the option if it has gained value. This can sometimes be a more profitable strategy, especially if the option’s market value exceeds the premium paid.

In summary, when you exercise a call option, the premium you initially paid is not reimbursed. The premium is a sunk cost and does not affect the strike price at which you buy the underlying asset. The total cost of acquiring the asset includes both the strike price and the premium. Your profit or loss is determined by comparing the market price of the asset to the total cost.